Imagine my disappointment on reading President Obama’s op-ed in the Financial Times, captioned “A firewall to stop Europe’s crisis spreading” that nothing resembling a firewall is actually discussed. Here’s the dictionary definition of a firewall:
a barrier inside a building or vehicle, designed to limit the spread of fire, heat and structural collapse
The op-ed on the other hand consists of a pitch for the president’s economic plan and a plea for the Europeans to get serious about addressing the euro’s problems. The problem with the euro is the euro. I will be greatly surprised if in ten years time all of the countries presently participating in the euro still are. Additionally, the Europeans are apparently of the opinion that if you ignore incentives long enough they will go away. If Greek debt is written down, why won’t Ireland, Portugal, Spain, and Italy demand the same?
Limiting the exposure of U. S. banks to the collapse of French and German banks would be a firewall. Constraining the IMF’s responses to addressing the euro’s problems would be a firewall. Passing the American Jobs Act? Not so much.
Dave Schuler: Additionally, the Europeans are apparently of the opinion that if you ignore incentives long enough they will go away. If Greek debt is written down, why won’t Ireland, Portugal, Spain, and Italy demand the same?
That’s always the problem, but there is a limit to how far that will go, as the lenders will eventually prefer defaults to continued writedowns. It’s similar to bankruptcy for corporations. Yes, there is an incentive for others to want to get writedowns, but there is also the problem of cascading bankruptcies.
But what would you suggest as a proper firewall in Europe?
As I’ve written before it seems to me that the Europeans’ two alternatives are for the members of the euro to draw closer politically and adopt a common fiscal policy in which the wealthier countries inevitably subsidize the poorer ones, much as New York has subsidized Tennessee over the last 50 years or to have at least some of the present members abandon the euro.
But I think the Europeans are fully capable of dealing with their own problems, unpleasant as that may be. I’m more concerned about a U. S. firewall against the collapse of French, German, etc. banks too greatly exposed to Greek, Portuguese, etc. debt.
“I’m more concerned about a U. S. firewall against the collapse of French, German, etc. banks too greatly exposed to Greek, Portuguese, etc. debt.”
There is no”firewall” against overexposure to bad debt other than regulation to prevent it from occurring in the first place. At this point we can either take failing banks into receivership (which is what should have been done in 2009) or we can engage in another round of Extend and Pretend with the Federal Reserve injecting more liquidity and swapping assets.
I agree with you about what should have been done re: the banks, Ben Wolf, but I think there are some actions that could still be taken. Like limiting the IMF’s exposure, encouraging banks to restrict their exposure to European banks, and so on.